Emergent BioSolutions Inc. - Quarter Report: 2013 September (Form 10-Q)

EMERGENT BIOSOLUTIONS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Basis of presentation and consolidation

The accompanying unaudited consolidated financial statements include the accounts of Emergent BioSolutions Inc. (the "Company" or "Emergent") and its wholly-owned and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

The unaudited consolidated financial statements included herein have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X issued by the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2012, as filed with the SEC.

In the opinion of the Company's management, any adjustments contained in the accompanying unaudited consolidated financial statements are of a normal recurring nature, and are necessary to present fairly the financial position of the Company as of September 30, 2013 and the results of operations, comprehensive income and cash flows for the three and nine months ended September 30, 2013 and 2012. Interim results are not necessarily indicative of results that may be expected for any other interim period or for an entire year.

There have been no significant changes to the Company's summary of significant accounting policies, contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2012, as filed with the SEC, during the three and nine months ended September 30, 2013, except for the addition of the Company's policy for multiple element revenue-generating arrangements and its revenue recognition policy related to the Company's contract with the Biomedical Advanced Research and Development Authority ("BARDA") to establish a Center for Innovation in Advanced Development and Manufacturing ("CIADM") and the addition of a policy for contingent purchase consideration obligations.

Revenue recognition

The Company analyzes its multiple element revenue-generating arrangements to determine whether the elements can be separated and accounted for individually as separate units of accounting. An item can generally be considered a separate unit of accounting if both of the following criteria are met: the delivered item(s) has value to the customer on a stand-alone basis and if the arrangement includes a general right of return and delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company. Items that cannot be divided into separate units are combined with other units of accounting, as appropriate. Consideration received is allocated among the separate units based on the unit's selling price and is recognized in full when the criteria are met. The Company deems services to be rendered if no continuing obligation exists on the part of the Company.

The Company's contract with the BARDA to establish a CIADM is a service arrangement that includes multiple elements. The CIADM contract requires the Company to provide a flexible infrastructure to supply medical countermeasures to the U.S. government over the contract period and includes such items as construction and facility design, workforce development and licensure of a pandemic flu vaccine. Since none of the individual elements by themselves satisfy the purpose of the contract, the Company has concluded that the CIADM contract elements cannot be separated as they do not have stand-alone value to the U.S. government. Therefore, the Company has concluded that there is a single unit of accounting associated with the CIADM contract. The Company recognizes revenue under the CIADM contract on a straight-line basis, based upon its estimate of the total payments to be received under the contract. The Company analyzes the estimated payments to be received on a quarterly basis to determine if an adjustment to revenue is required. Changes in estimates attributed to modifications in the estimate of total payments to be received are recorded prospectively.

Contingent purchase consideration obligations

In accordance with the terms of the Company's August 2013 acquisition of the Healthcare Protective Products Division ("HPPD"), a division of Bracco Diagnostics Inc. ("Bracco"), the Company has committed to make potential payments to Bracco based on achievement of certain net sales thresholds of RSDL through 2028. The Company records this obligation at fair value. Contingent purchase consideration is based on a percentage of future net RSDL sales. The fair value model used to calculate this obligation is based on the income approach (a discounted cash flow model) that has been risk adjusted based on the probability of achievement of net sales.

The inputs the Company uses for determining the fair value of the contingent purchase consideration are Level 3 fair value measurements. The Company re-evaluates the fair value on a quarterly basis. Changes in the fair value can result from adjustments to the discount rates and updates in the assumed timing of or achievement of net sales. Any future increase in the fair value of the contingent purchase consideration obligation is based on an increased likelihood that the underlying net sales will be achieved and the associated payment or payments which will therefore become due and payable, which will result in a charge to cost of product sales in the period in which the increase is determined. Similarly, any future decrease in the fair value of the contingent purchase consideration obligation will result in a reduction in cost of product sales.

2. Acquisition of Healthcare Protective Products Division

On August 1, 2013, the Company acquired substantially all of the assets of the HPPD, a division of Bracco, for approximately $24.1 million in cash along with contingent purchase consideration obligations to Bracco. The assets acquired in this acquisition include HPPD's product, RSDL, and a majority of the customer and distributor agreements associated with RSDL. In addition, as part of the acquisition, the Company will acquire from Bracco, for approximately $1.8 million, the remaining HPPD assets, which primarily include manufacturing equipment. These remaining HPPD assets and the associated liability, have been included in the Company's consolidated balance sheets as of September 30, 2013.  The Company anticipates the acquisition of the remaining assets will occur during the fourth quarter of 2013. The acquisition diversifies the Biodefense segment by adding product sales from RSDL.

The contingent purchase consideration obligations is based on a percentage of RSDL net sales, ranging from 5-10%, for the period August 1, 2013 through July 31, 2028.  At August 1, 2013, the contingent purchase consideration obligation was recorded at a fair value of $16.2 million. The Level 3 fair value of these obligations are based on management's assessment of the potential future realization of the contingent purchase consideration payments. This assessment is based on inputs that have no observable market.  The obligation is measured using the income approach (a discounted cash flow model).

The table below summarizes the preliminary allocation of the purchase price based upon fair values of assets acquired and liabilities assumed at August 1, 2013.  This preliminary allocation is based upon information that was available to management at the time the financial statements were prepared.  Accordingly, the allocation may change. The allocation is not yet final pending the valuation of acquired property, plant and equipment, intangible assets and pre-acquistion contingent liabilites, as well as the assessment of amoritzation periods for intangible assets.

A substantial portion of the assets acquired from Bracco consisted of intangible assets associated with the RSDL product.  As of the date of acquisition, the Company has recorded intangible assets of approximately $28.1 million related to RSDL and $3.5 million related to a manufacturing agreement with Bracco. For each of the three and nine month periods ended September 30, 2013, the Company recorded $779,000 in amortization for intangible assets, which have been recorded in cost of product sales within the Company's Biodefense segment.

The Company recorded approximately $8.8 million in goodwill related to the HPPD acquisition representing the purchase price paid in the acquisition in excess of the fair value of the tangible and intangible assets acquired. This goodwill is included in the Company's Biodefense segment. None of the goodwill generated from the HPPD acquisition is expected to be deductible for tax purposes.

The Company has incurred transaction costs related to the HPPD acquisition of approximately $283,000 and $800,000, respectively, for the three and nine month periods ended September 30, 2013, which have been recorded in selling, general and administrative expenses within the Company's Biodefense segment.

The Company has determined that the transaction was not significant, and as such no proforma disclosures were required.

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability, an exit price, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value, include: 

Level 1 — Observable inputs for identical assets or liabilities such as quoted prices in active markets;

Level 2 — Inputs other than quoted prices in active markets that are either directly or indirectly observable; and

Level 3 — Unobservable inputs in which little or no market data exists, which are therefore developed by the Company using estimates and assumptions that reflect those that a market participant would use.

 

The following table represents the Company's fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis:

During the periods ended September 30, 2013 and December 31, 2012, the Company did not have any transfers between Level 1 and Level 2 assets or liabilities.

As of September 30, 2013 and 2012, the Company had no assets or liabilities measured at fair value using significant unobservable inputs (Level 3) except for contingent value right ("CVR") and contingent purchase consideration obligations.

The fair value of the CVR obligations is based on management's assessment of certain development and collaboration milestones, which are inputs that have no observable market (Level 3). The obligation is measured using a discounted cash flow model. During the nine months ended September 30, 2012, the Company recorded a decrease in the CVR obligations of $3.0 million due to Pfizer ceasing development of programs related to the CVR milestones and made a $1.7 million CVR payment under the Company's agreement with Abbott. The adjustment to fair value is classified in the Company's statement of operations as research and development expense within the Company's Biosciences segment.

The fair value of contingent purchase consideration obligations are based on management's assessment of changes as a result of adjustments to the discount rates and updates in the assumed and actual achievement of net sales for RSDL, which are inputs that have no observable market (Level 3). For the three and nine months ended September 30, 2013, the contingent purchase consideration increased by $349,000 primarily due to an adjustment to the discount rate and the timing of RSDL sales.  The adjustment to fair value is classified in the Company's statement of operations as cost of product sales within the Company's Biodefense segment.

The following table is a reconciliation of the beginning and ending balance of the liabilities measured at fair value using significant unobservable inputs (Level 3) during the year ended September 30, 2013 and December 31, 2012:

Separate disclosure is required for assets and liabilities measured at fair value on a recurring basis, as described above, from those measured at fair value on a nonrecurring basis. For the nine months ended September 30, 2013, no assets or liabilities were measured at fair value on a nonrecurring basis. For the year ended December 31, 2012, the Company's SBI-087 in-process research and development ("IPR&D") asset, which was categorized as a Level 3 fair value measurement, was the only asset or liability measured at fair value on a nonrecurring basis (see Note 5).

Inventories consist of the following:

During the nine months ended September 30, 2012, Pfizer terminated its development program with respect to the Company's SBI-087 product candidate. The Company considered this termination a potential indicator of impairment of the related SBI-087 IPR&D asset, and assessed the fair value of this asset. As part of the assessment, the Company considered the impact of Pfizer's decision, along with the Company's decision to no longer pursue further development of this asset due to reduced overall probability of success and increased development costs for the product candidate. As a result, the Company recorded an impairment charge of $9.6 million during the nine months ended September 30, 2012, which represented the entire carrying value of the SBI-087 IPR&D asset. This charge is classified in the Company's statement of operations as impairment of in-process research and development, within the Company's Biosciences segment.

As a result of the impairment of the SBI-087 IPR&D asset, the Company also performed an analysis of the Biosciences therapeutic reporting unit at September 30, 2012, and concluded that the $5.5 million in goodwill was not more likely than not impaired and therefore an interim impairment analysis was deemed unnecessary. As of September 30,  2013 and December 31, 2012, the Company had goodwill assocated with the Biosciences Therapurtic reporting unit of $5.5 million.

The following is a summary of stock option award activity under the Second Amended and Restated Emergent BioSolutions Inc., 2006 Stock Incentive Plan (the "2006 Plan") and the Emergent BioSolutions Employee Stock Option Plan (the "2004 Plan"):

The following is a summary of restricted stock unit award activity under the 2006 Plan:

During the nine months ended September 30, 2013, the Company corrected an immaterial prior period classification error for the nine  months ended September 30, 2012 of approximately $3.0 million. This immaterial error related to the cash flow presentation of the excess tax benefit attributed to the exercise of non-qualified stock options and restricted stock units and had no impact on the Company's consolidated cash flows, consolidated statements of operations and comprehensive income or the consolidated balance sheets. The correction of the error is reflected as a reduction of originally reported operating cash flow from operating activities and an increase in originally reported cash flow from financing activities.

 

In July 2008, the Company entered into a collaboration with the University of Oxford ("Oxford") and certain Oxford researchers to advance a vaccine product candidate for tuberculosis, resulting in the formation of the Oxford-Emergent Tuberculosis Consortium ("OETC"). The Company has a 51% equity interest in OETC. In February 2013, the Company published data from the Phase IIb clinical trial which showed its tuberculosis vaccine product candidate did not confer statistically significant protection for the tuberculosis disease or infection in infants from those vaccinated at birth with the Baccile Calmette-Guerin vaccine. As a result of this clinical trial data, the Company has ceased development work on this product candidate and expects future funding of OETC to be minimal while the OETC entity is liquidated.

The Company evaluates its variable interests in OETC on a quarterly basis and has determined that it is the primary beneficiary as it has directed the activities of OETC that most significantly impact OETC's economic performance and, as a result, will absorb the majority of expected losses. Accordingly, the Company consolidates OETC. As of September 30, 2013 and 2012, respectively, assets of $308,000 and $1.6 million, respectively, and liabilities of $243,000 and $2.8 million, respectively, related to OETC were included within the Company's consolidated balance sheets. During the three months ended September 30, 2013, OETC did not incur any net losses. During the nine months ended September 30, 2013, OETC incurred a net loss of $1.8 million, of which, $905,000 is included in the Company's consolidated statement of operations. During the three and nine months ended September 30, 2012, OETC incurred net losses of $2.0 million and $8.5 million, respectively, of which $1.0 million and $4.3 million, respectively, are included in the Company's consolidated statement of operations.

In conjunction with the establishment of OETC, the Company granted a put option to Oxford and certain Oxford researchers whereby the Company may be required to acquire all of the OETC shares held by Oxford and the Oxford researchers at the fair market value of the underlying shares. This put option is contingent upon the satisfaction of a number of conditions that must exist or occur subsequent to the granting by the European Commission of marketing authorization for the OETC-sponsored tuberculosis vaccine product candidate. The Company accounts for the put option in accordance with the accounting provisions related to derivatives and distinguishing liabilities from equity. In accordance with these provisions, the Company has determined that the put option had no value as of September 30, 2013.

The following is a summary of the stockholders' equity attributable to the Company and the noncontrolling interests:

Abbott Laboratories

In August 2009, Trubion Pharmaceuticals, Inc. ("Trubion"), which the Company acquired in October 2010, entered into a collaboration agreement with Facet Biotech Corporation, now a wholly-owned subsidiary of Abbott Laboratories ("Abbott"), for the joint worldwide development and commercialization of otlertuzumab (formerly TRU-016). The collaboration agreement was terminated on March 20, 2012 and all rights to otlertuzumab and other CD37-directed protein therapeutics under the collaboration agreement reverted back to the Company.

During the nine months ended September 30, 2012, respectively, the Company recorded revenue of $2.7 million for collaborative research and development services pursuant to the Abbott agreement, which is included in the Company's financial statements of operations as contracts and grants revenue within the Company's Biosciences segment. There was no revenue for the three months ended September 30, 2013 and 2012 and the nine months ended September 30, 2013.

Pfizer Inc.

In December 2005, Trubion entered into an agreement (the "Pfizer Agreement") with Wyeth Pharmaceuticals, now a wholly-owned subsidiary of Pfizer, for the development and worldwide commercialization of CD20-directed therapeutics. In May 2011, the Company and Pfizer entered into a third amendment to the Pfizer Agreement (the "Biosimilar Amendment") in which the Company released certain restrictions related to the development and commercialization of biosimilar CD20 antibodies. Under the terms of this amendment, the Company is entitled to receive royalty payments in the low-single digits on net sales of certain Pfizer biosimilar products directed to CD20, subject to the satisfaction of specified conditions. In September 2012, the Pfizer Agreement was terminated. The Company's right to receive royalty payments under the Biosimilar Amendment survives termination of the Pfizer Agreement.

During the three and nine months ended September 30, 2012, the Company recorded revenue of $356,000 and $1.2 million for research and development services pursuant to the Pfizer agreement, which is included in the Company's statement of operations as contracts and grants revenue within the Company's Biosciences segment. There was no revenue for the three and nine months ended September 30, 2013.

 

9. Restructuring

In February 2013, the Company adopted a plan to restructure the operations of Emergent Product Development UK Limited ("EPDU") and OETC due to the results of the Phase IIb clinical trial for the Company's tuberculosis vaccine product candidate. The Company completed this restructuring as of June 30, 2013, except for the payment of certain termination benefit obligations that remain payable as of September 30, 2013.

The restructuring plan included a headcount reduction of 14 employees at EPDU, the termination of a facility lease, and the impairment of leasehold improvements and equipment. These costs, which are included in selling, general and administrative expense in the Company's statement of operations and are included within the Biosciences segment, are detailed below:

The following is a summary of the activity for the liabilities related to the EPDU restructuring:

10. Business interruption insurance recovery

During the nine months ended September 30, 2012, the Company recorded $1.7 million from an insurance recovery related to a power outage at its Lansing, Michigan facility. The insurance recovery is classified in the Company's statement of operations as other income (expense), net.

11. Earnings per share

The following table presents the calculation of basic and diluted net income per share:

  Stock options with exercise prices in excess of the average per share closing price during the period are not considered in the calculation of fully diluted earnings per share. For the three and nine month periods ended September 30, 2013, approximately 1.4 million and 1.5 million stock options, respectively, were excluded from the calculation of diluted earnings per share. For the three and nine month periods ended September 30, 2012, approximately 3.0 million and 2.9 million stock options, respectively, were excluded from the calculation of diluted earnings per share.

12. Segment information

For financial reporting purposes, the Company reports financial information for two business segments: Biodefense and Biosciences. The Company's two business segments, or operating divisions, engage in business activities for which discrete financial information is reviewed by the chief operating decision maker. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. The Company's reportable segments are composed of business units that offer different products and product candidates and are managed separately because they manufacture and develop distinct products and product candidates with different development processes.

 

	Reportable Segments
(in thousands)	Biodefense				Biosciences				All Other				Total
Three Months Ended September 30, 2013
External revenue		$	89,102			$	-			$	-			$	89,102
Net income (loss)			27,175				(12,491	)			(1,193	)			13,491
Three Months Ended September 30, 2012
External revenue		$	66,238			$	354			$	-			$	66,592
Net income (loss)			20,760				(12,165	)			(1,978	)			6,617
	Reportable Segments
(in thousands)	Biodefense				Biosciences				All Other				Total
Nine Months Ended September 30, 2013
External revenue		$	213,663			$	975			$	-			$	214,638
Net income (loss)			56,780				(38,019	)			(2,848	)			15,913
Nine Months Ended September 30, 2012
External revenue		$	181,838			$	5,444			$	-			$	187,282
Net income (loss)			59,361				(47,019	)			(4,925	)			7,417

Development Programs	Funding Source	Award Date	Performance Period
Post-Exposure Prophylaxis indication for BioThrax	BARDA	9/2007	9/2007 — 3/2016
NuThrax	NIAID	7/2008	7/2008 — 6/2013
Large-scale manufacturing for BioThrax	BARDA	7/2010	7/2010 — 7/2015
NuThrax	NIAID	7/2010	8/2010 — 8/2014
PreviThrax	BARDA	9/2010	9/2010 — 9/2015
CIADM	BARDA	6/2012	6/2012 — 6/2037

		Three Months Ended
		September 30,
(in thousands)		2013				2012
Biodefense:
Large-scale manufacturing for BioThrax		$	4,865			$	4,521
BioThrax related programs			2,750				2,376
PreviThrax			3,795				4,054
NuThrax			2,434				1,752
Thravixa			-				491
Other Biodefense			2,293				1,946
Total Biodefense			16,137				15,140
Biosciences:
Tuberculosis vaccine			84				3,217
otlertuzumab (formerly TRU-016)			6,658				3,372
ES414 (formerly T-Scorp)			1,810				1,375
ES301 (formerly DRACO)			-				175
Other Biosciences			2,522				2,359
Total Biosciences			11,074				10,498
Other			1,726				1,752
Total		$	28,937			$	27,390

		Nine Months Ended September 30,
(in thousands)		2013				2012
Net cash provided by (used in):
Operating activities(1)		$	88,333			$	78,660
Investing activities			(58,540	)			(27,212	)
Financing activities			1,102				2,552
Net increase in cash and cash equivalents		$	30,895			$	54,000

 

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2013. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2013, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

No change in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, occurred during the quarter ended September 30, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Management's assessment of and conclusion on the effectiveness of disclosure controls and procedures and internal controls over financial reporting did not include the internal controls related to the operations acquired in the acquisition of the Health Protective Products Division, or HPPD,  from Bracco Diagnostics Inc.  Included in our consolidated financial statements related to the operations of HPPD are total assets and net assets of $48.8 million and $26.6 million, respectively, as of September 30, 2013 and $7.0 million and $2.5 million of revenues and net income for the period since acquisition, or August 1, 2013 through September 30, 2013.

Not applicable.

ITEM 1A.  RISK FACTORS

A number of risk factors could cause our actual results to differ materially from those that are indicated by forward-looking statements. You should carefully consider these risk factors in evaluating our business because these risk factors may have a significant impact on our business, financial condition and results of operations. The risks described below are not the only risks we may face. Additional risks and uncertainties not presently apparent to us, or risks that we currently consider immaterial, could also negatively affect our business, financial condition and results of operations.

We derive the majority of our revenue from sales of BioThrax to our principal customer, the U.S. government. If the U.S. government's demand for BioThrax is reduced, our business, financial condition and operating results could be materially harmed.

We have derived and expect for the foreseeable future to continue to derive the majority of our revenue from sales to the U.S. government of BioThrax, our FDA-approved anthrax vaccine. We are currently party to a contract with the Centers for Disease Control and Prevention, or CDC, for the supply of up to 44.75 million doses of BioThrax for placement into the Strategic National Stockpile, or SNS, over a five year period ending in September 2016.

The procurement of doses of BioThrax by the CDC is subject to the availability of funding. Our existing contract with the CDC does not guarantee that funding for the procurement of doses will be made available. If the SNS priorities change, funding to procure doses of BioThrax may be limited or not available at all, and our business, financial condition and operating results would be materially harmed. The success of our business and our operating results for the foreseeable future are substantially dependent on the terms of our BioThrax sales to the U.S. government, including the price per dose, the number of doses and the timing of deliveries.

Our U.S. government contracts require ongoing funding decisions by the U.S. government. Reduced or discontinued funding of these contracts, including funding implications of the federal budget sequestration provisions, could cause our financial condition and operating results to suffer materially.

Our principal customer for BioThrax and RSDL is the U.S. government. We anticipate that the U.S. government will also be a principal customer for other biodefense products that we successfully develop or acquire. Additionally, the majority of our revenue is from U.S. government development contracts and grants. Over its lifetime, a U.S. government program may be implemented through the award of many different individual contracts and subcontracts. The funding for government programs is subject to Congressional appropriations, generally made on a fiscal year basis, even for programs designed to continue for several years. These appropriations can be subject to political considerations and stringent budgetary constraints. For example, sales of BioThrax supplied under our multi-year procurement contract with the CDC are subject to available funding, mostly from annual appropriations. Additionally, our government-funded development contracts typically give the U.S. government the right, exercisable in its sole discretion, to extend these contracts for successive option periods following a base period of performance. The value of the services to be performed during these option periods may constitute the majority of the total value of the underlying contract. For example, the development contract we were awarded in September 2010 for development of PreviThrax consists of an approximately three-year base period of performance valued at approximately $51 million and three successive one-year option periods valued at a total of approximately $101 million. If levels of government expenditures and authorizations for biodefense decrease or shift to programs in areas where we do not offer products or are not developing product candidates, or if the U.S. government otherwise declines to exercise its options under our contracts with it, our business, revenues and operating results would suffer.

In August 2011, Congress enacted the Budget Control Act of 2011, or BCA, committing the U.S. government to significantly reduce the federal deficit over ten years. The BCA contains provisions commonly referred to as "sequestration" which call for substantial, unspecified automatic federal spending cuts that may continue for a period of ten years. On October 16, 2013, Congress passed legislation suspending the federal debt ceiling until February 7, 2014 and establishing a Congressional conference committee to deliver a budget recommendation by December 13, 2013. We cannot predict the ultimate outcome of the budget process or whether such efforts will result in significant funding delays or cancellation of orders by the U.S. government, any of which may adversely impact our business and results of operations.

The government contracting process is typically a competitive bidding process and involves risks and requirements that are not present in commercial contracting.

We expect that a significant portion of our near-term business will be under government contracts and grants, which may be awarded through competitive bidding. Competitive bidding for government contracts presents a number of risks or requirements, some of which are not typically present in the commercial contracting process, including:

§	the commitment of substantial time and attention of management and key employees to the preparation of bids and proposals for contracts that may not be awarded to us;

§	the need to accurately estimate the resources and cost structure that will be required to perform any contract that we might be awarded;

§	the possibility that we may be ineligible to respond to a request for proposal issued by the government;

§	the submission by third parties of protests to our responses to requests for proposal that could result in delays or withdrawals of those requests for proposal; and

§

in the event our competitors protest or challenge contract or grant awards made to us pursuant to competitive bidding, the potential that we may incur expenses or delays, and that any such protest or challenge would result in the resubmission of bids based on modified specifications, or in the termination, reduction or modification of the awarded contract.

The U.S. government may choose not to award us future contracts for the development and supply of anthrax vaccines and other Biodefense product candidates that we are developing, and may instead award such contracts to our competitors. If we are unable to win particular contracts, we may not be able to operate in the market for products that are provided under those contracts for a number of years. Additionally, if we are unable to consistently win new contract awards over an extended period, or if we fail to anticipate all of the costs and resources that will be required to secure and, if applicable, perform such contract awards, our growth strategy and our business, financial condition and operating results could be materially and adversely affected.

Laws and regulations affecting government contracts make it more costly and difficult for us to successfully conduct our business. Failure to comply with these laws could result in significant civil and criminal penalties and materially damage our relationship with the U.S. government.

We must comply with numerous laws and regulations relating to the formation, administration and performance of government contracts. Among the most significant government contracting regulations that affect our business are:

§	the Federal Acquisition Regulation, or FAR, and agency-specific regulations supplemental to the FAR, which comprehensively regulate the procurement, formation, administration and performance of government contracts;

§

the business ethics and public integrity obligations, which govern conflicts of interest and the hiring of former government employees, restrict the granting of gratuities and funding of lobbying activities and incorporate other requirements such as the Anti-Kickback Act, the Procurement Integrity Act, the False Claims Act and the Foreign Corrupt Practices Act;

§	export and import control laws and regulations; and

§	laws, regulations and executive orders restricting the use and dissemination of information classified for national security purposes and the exportation of certain products and technical data.

U.S. government agencies routinely audit and investigate government contractors for compliance with applicable laws and standards. If we are audited and such audit was to uncover improper or illegal activities, we could be subject to civil and criminal penalties, administrative sanctions, including suspension or debarment from government contracting, and significant reputational harm.

The amount we are paid under our fixed price government contracts is based on estimates we have made of the time, resources and expenses required for us to perform those contracts. If our actual costs exceed our estimates, we may not be able to earn an adequate return or may incur a loss under these contracts, which could harm our operating results and materially reduce our net income.

Our current contracts with the CDC for the procurement of BioThrax and with the DoD for procurement of RSDL are fixed price contracts. We expect that our potential future contracts with the U.S. government for BioThrax and RSDL, as well as contracts for other biodefense products, also may be fixed price contracts. Under a fixed price contract, we are required to deliver our products at a fixed price regardless of the actual costs we incur. Estimating costs that are related to performance in accordance with contract specifications is difficult, particularly where the period of performance is over several years. Our failure to anticipate technical problems, estimate costs accurately or control costs during performance of a fixed price contract could reduce the profitability of a fixed price contract or cause a loss, which could harm our operating results and materially reduce our net income.

Unfavorable provisions in government contracts, some of which may be customary, may subject our business to material limitations, restrictions and uncertainties and may have a material adverse impact on our financial condition and operating results.

Government contracts customarily contain provisions that give the U.S. government substantial rights and remedies, many of which are not typically found in commercial contracts, including provisions that allow the U.S. government to:

§	terminate existing contracts, in whole or in part, for any reason or no reason;

§	unilaterally reduce or modify contracts or subcontracts, including by imposing equitable price adjustments;

§	cancel multi-year contracts and related orders if funds for contract performance for any subsequent year become unavailable;

§	decline, in whole or in part, to exercise an option to purchase product under a contract or renew a contract;

§	claim rights to facilities or to products, including intellectual property, developed under the contract;

§	require repayment of contract funds spent on construction of facilities in the event of contract default;

§	take actions that result in a longer development timeline than expected;

§	direct the course of a development program in a manner not chosen by the government contractor;

§	suspend or debar the contractor from doing business with the government or a specific government agency;

§	pursue civil or criminal remedies under acts such as the False Claims Act and False Statements Act; and

§	control or prohibit the export of products.

Generally, government contracts, including our CDC contract for procurement of BioThrax, contain provisions permitting unilateral termination or modification, in whole or in part, at the U.S. government's convenience. Under general principles of government contracting law, if the U.S. government terminates a contract for convenience, the government contractor may recover only its incurred or committed costs, settlement expenses and profit on work completed prior to the termination. If the U.S. government terminates a contract for default, the government contractor is entitled to recover costs incurred and associated profits on accepted items only and may be liable for excess costs incurred by the government in procuring undelivered items from another source. Our CDC contract is, and other future government contracts are likely to be, terminable at the U.S. government's convenience with these potential consequences.

Our U.S. government contracts grant the U.S. government the right to use technologies developed by us under the government contract or the right to share data related to our technologies, for or on behalf of the U.S. government. Under our U.S. government contracts, we might not be able to prohibit third parties, including our competitors, from access to such technology or data in providing products and services to the U.S. government.

BioThrax and our biologic product candidates are complex to manufacture and ship, which could cause us to experience delays in product manufacturing or development and resulting delays in revenues.

BioThrax and all of our current product candidates are biologics. Manufacturing biologic products, especially in large quantities, is complex. The products must be made consistently and in compliance with a clearly defined manufacturing process. Problems may arise during manufacturing for a variety of reasons, including problems with raw materials, equipment malfunction and failure to follow specific protocols and procedures. In addition, slight deviations anywhere in the manufacturing process, including obtaining materials, maintaining master seed or cell banks and preventing genetic drift, seed or cell growth, fermentation, filtration, filling, labeling, packaging, storage and shipping, and quality control testing, may result in lot failures or manufacturing shut-down, delays in the release of lots, product recalls, spoilage or regulatory action. Additionally, as our equipment ages, it will need to be replaced. Replacement of equipment has the potential to introduce variations in the manufacturing process that may result in lot failures or manufacturing shut-down, delay in the release of lots, product recalls, spoilage or regulatory action. Success rates can also vary dramatically at different stages of the manufacturing process, which can reduce yields and increase costs. From time to time, we may experience deviations in the manufacturing process that may take significant time and resources to resolve and if unresolved may affect manufacturing output and could cause us to fail to satisfy customer orders or contractual commitments, lead to a termination of one or more of our contracts, lead to delays in our clinical trials, result in litigation or regulatory action against us or cause the FDA to cease releasing product until the deviations are explained and corrected, any of which could be costly to us, damage our reputation and negatively impact our business.

FDA approval is required for the release of each lot of BioThrax. We will not be able to sell any lots that fail to satisfy the release testing specifications. For example, we must provide the FDA with the results of certain tests, including potency tests, before lots are released for sale. We have one mechanism for conducting this potency testing that is reliant on a unique animal strain for which we currently have no alternative. In developing alternatives, we may face significant regulatory hurdles. In the event of a problem with this strain, if we have not developed alternatives, we would not be able to provide the FDA with required potency testing data and would not be able to release product, and therefore would not be able to sell any more BioThrax doses until the problem was resolved.

Additionally, potency testing of each lot of BioThrax is performed against a qualified control lot that we maintain. We continually monitor the status of our control lot and periodically produce and qualify a new control lot to replace the existing control lot. If we are not able to produce and qualify a new control lot or otherwise satisfy the FDA's requirements for release of BioThrax, our ability to sell BioThrax would be impaired until such time as we become able to meet the FDA's requirements, which would significantly impact our revenues, require us to utilize our cash balances to help fund our ongoing operations and otherwise harm our business.

We are contractually required to ship BioThrax at a prescribed temperature range, and variations from that temperature range could result in loss of product and could significantly impact our revenues. Delays, lot failures, shipping deviations, spoilage or other loss during shipping could cause us to fail to satisfy customer orders or contractual commitments, lead to a termination of one or more of our contracts, lead to delays in our clinical trials or result in litigation or regulatory action against us, any of which could be costly to us and otherwise harm our business.

We are in the process of expanding our manufacturing facilities. Delays in completing our facilities, or delays or failures in obtaining regulatory approvals for our new manufacturing facilities, could limit our ability to expand our revenues.

We have constructed Building 55, a large-scale manufacturing facility on our Lansing, Michigan campus for which we received a development contract from BARDA in July 2010 for scale-up, qualification and validation to manufacture BioThrax. Additionally, in 2009, we acquired a facility in Baltimore, Maryland, which we expect to utilize for certain product development or manufacturing projects, including projects performed under a separate development contract from BARDA to establish a Center for Innovation in Advanced Development and Manufacturing. The process for qualifying and validating these facilities may result in unanticipated delays and may cost more than expected due to a number of factors, including regulatory requirements. The costs and time required to comply with current good manufacturing practices, or cGMP, regulations or similar foreign regulatory requirements for sales of our products may be significant. In addition, if we experience delays, we may be in breach of the obligations under our government funded development contracts. If our facility licensure activities are delayed, we may not be able to utilize Building 55 to increase our production of BioThrax or manufacture product candidates in our Baltimore facility, which could significantly impact our revenues.

Currently, only our manufacturing facility in Lansing, Michigan has regulatory approval to manufacture BioThrax. A significant interruption of the ability of that facility to manufacture BioThrax would reduce our revenues and materially harm our business, financial condition and operating results.

We currently rely on our manufacturing facility at a single location in Lansing, Michigan for the production of BioThrax. Any interruption in manufacturing operations at this location could result in our inability to satisfy the product demand of the U.S. government or other BioThrax customers. A number of factors could cause interruptions, including:

§	equipment malfunctions or failures;

§	technology malfunctions;

§	cyber-attacks;

§	work stoppages or slow-downs;

§	protests, including by animal rights activists;

§	damage to or destruction of the facility; or

§	product tampering.

Providers of bioterrorism countermeasures could be subject to an increased risk of terrorist activities. The U.S. government has designated both our Lansing, Michigan and Baltimore, Maryland facilities as facilities requiring additional security. Although, we continually evaluate and update security measures, there can be no assurance that any additional security measures would protect our facilities from terrorist efforts determined to disrupt our manufacturing activities.

The factors listed above could also cause disruptions at our other facilities, including our research and product development facilities. Any such disruption, damage, or destruction of our facilities could impede our ability to manufacture BioThrax and our other products and product candidates, result in losses and delays, including delay in the performance of our contractual obligations or delay in our clinical trials, any of which could be costly to us and materially harm our business, financial condition and operating results.

If we are unable to obtain supplies for the manufacture of BioThrax or our other products and product candidates in sufficient quantities and at an acceptable cost, our ability to manufacture BioThrax or to develop and commercialize our other products and product candidates could be impaired, which could harm our revenues, lead to a termination of one or more of our contracts, lead to delays in clinical trials or otherwise harm our business.

We depend on certain single-source suppliers for materials and services necessary for the manufacture of BioThrax and our other products and product candidates. A disruption in the availability of such materials or services from these suppliers could require us to qualify and validate alternative suppliers. If we are unable to locate or establish alternative suppliers, our ability to manufacture BioThrax or our other products and product candidates could be adversely affected and could harm our revenues, cause us to fail to satisfy contractual commitments, lead to a termination of one or more of our contracts or lead to delays in our clinical trials, any of which could be costly to us and otherwise harm our business, financial condition and operating results.

We are currently dependent on third party manufacturers for the manufacture of some of our products and product candidates, other than BioThrax. Certain of our third party manufacturers currently constitute the sole source of one or more of our other products and product candidates, and we have and will continue to have limited control over the manufacturing process and costs of these products and product candidates.

Third party manufacturers currently supply a significant amount of our products and product candidates, other than BioThrax, pursuant to contractual arrangements. Certain manufacturers currently constitute the sole source of several of our products and product candidates. For example, Therapex Inc. is our sole source manufacturer for RSDL. Because of contractual restraints and the lead-time necessary to obtain FDA approval of a new manufacturer, replacement of any of these manufacturers may be expensive and time consuming and may cause interruptions in our supply of products to our customers or our product candidates for use in clinical trials. As a result, any such delay could adversely affect our ability to satisfy current contractual requirements and our product development efforts in general.

We have a limited ability to control the manufacturing process or costs related to the third party manufacture of our products and product candidates. Increases in the prices we pay our manufacturers, interruptions in the supply of our products and product candidates or lapses in quality could adversely impact our clinical and non-clinical trials, margins, profitability and cash flows. We are reliant on our third party manufacturers to maintain the facilities at which they manufacture our products and product candidates in compliance with all FDA and other applicable regulatory requirements. If these manufacturers fail to maintain compliance with FDA or other applicable regulatory requirements, they could be ordered to cease manufacturing, which would have a materially adverse impact on the supply of these products and product candidates to satisfy government and commercial demand and demand for our clinical and non-clinical trials. For example, in 2008, the initial manufacturer of Thravixa informed us it was discontinuing contract manufacturing operations, forcing us to secure an alternative manufacturing source to continue development and trials of this product candidate.

We may be forced to consider entering into additional manufacturing arrangements with other third party manufacturers. In each case, we will incur significant costs and time in obtaining the regulatory approvals for these third party facilities and in taking the necessary steps to prepare these third parties for the manufacture of our products and product candidates.

Our use of hazardous materials, chemicals, bacteria and viruses requires us to comply with regulatory requirements and exposes us to significant potential liabilities.

Our operations involve the use of hazardous materials, including chemicals, bacteria, viruses and radioactive materials, and may produce dangerous waste products. Accordingly, we, along with the third parties that conduct clinical trials on and manufacture our products and product candidates on our behalf are subject to federal, state, local and foreign laws and regulations that govern the use, manufacture, distribution, storage, handling, disposal and recordkeeping with respect to these materials. The Public Health Security and Bioterrorism Preparedness and Response Act and the Agricultural Protection Act require us to register with the CDC and the Animal and Plant Health Inspection Service, our possession, use or transfer of select biological agents or toxins that could pose a threat to public health and safety, to animal or plant health or to animal or plant products. This legislation requires stringent safeguards and security measures for these select agents and toxins, including controlled access and the screening of entities and personnel and establishes a comprehensive national database of registered entities. We are also subject to a variety of environmental laws. Compliance with current or future laws and regulations can require significant costs and we could be subject to substantial fines and penalties in the event of noncompliance. Although we believe that our safety procedures for handling and disposing of these materials comply with regulatory requirements, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of an accident, we could be held liable for substantial civil damages or costs associated with the cleanup of hazardous materials. Any related liability might not be fully covered by insurance, could exceed our resources and could have a material adverse effect on our business. In addition to complying with environmental and occupational health and safety laws, we must comply with special regulations relating to biosafety administered by the CDC, Health and Human Services, or HHS, U.S. Department of Agriculture and the Department of Defense, or DoD.

Our business depends on our success in developing and commercializing our product candidates. If we are unable to commercialize these product candidates, or experience significant delays or unanticipated costs in doing so, our business would be materially and adversely affected.

We have invested significant efforts and financial resources in the development of our vaccines and therapeutic product candidates and the acquisition of additional product candidates. In addition to BioThrax and RSDL sales, our ability to generate revenue is dependent on the success of our development programs, on the U.S. government's interest in providing development funding for or procuring certain of our product candidates, on the interest of non-governmental organizations and other commercial entities in providing grant funding for development of certain of our product candidates and on the commercial viability of our developed or acquired product candidates. The commercial success of our product candidates will depend on many factors, including accomplishing the following in an economical manner:

§	successful development, formulation and cGMP scale-up of biological manufacturing that meets FDA requirements;

§	successful completion of clinical or non-clinical development, including toxicology studies and studies in approved animal models;

§	receipt of marketing approvals from the FDA and equivalent foreign regulatory authorities;

§	establishment of commercial manufacturing processes and product supply of our own or arrangements with contract manufacturers;

§	establishment of a commercial sales force for the product, whether alone or in collaboration with others; and

§	acceptance of the product by potential government customers, physicians, patients, healthcare payors and others in the medical community.

If we are delayed or prevented from developing or commercializing a product candidate in an economically acceptable manner, or if doing so requires us to incur significant unanticipated costs, our growth could be materially and adversely affected.

Clinical trials of product candidates are expensive and time-consuming, and their outcome is uncertain. We must invest substantial amounts of time and financial resources to these trials, which may not yield viable products.

Before obtaining regulatory approval for the sale of our product candidates, we and our collaborative partners must conduct extensive preclinical studies and clinical trials to establish proof of concept and demonstrate the safety and efficacy of our product candidates. Preclinical and clinical testing is expensive, difficult to design and implement, can take many years to complete and is uncertain as to outcome. Success in preclinical testing and early clinical trials does not ensure that later clinical trials or animal efficacy studies will be successful, and interim results of a clinical trial or animal efficacy study do not necessarily predict final results. An unexpected result in one or more of our clinical trials can occur at any stage of testing.

For certain of our Biodefense product candidates, we expect to rely on FDA regulations known as the "animal rule" to obtain approval. The animal rule permits, in certain limited circumstances, the use of animal efficacy studies together with human clinical safety and immunogenicity trials to support an application for marketing approval. These regulations are relatively new, and we have limited experience in the application of these rules to the product candidates that we are developing. It is possible that results from these animal efficacy studies may not be predictive of the actual efficacy of our product candidates in humans. Under the Project BioShield Act of 2004, the Secretary of HHS can contract to purchase countermeasures for the SNS prior to FDA approval of the countermeasure in specified circumstances. Project BioShield also allows the FDA commissioner to authorize the emergency use of medical products that have not yet been approved by the FDA. If our Biodefense product candidates are not selected under this Project BioShield authority, they generally will have to be approved by the FDA through traditional regulatory mechanisms.

We may experience unforeseen events or issues during, or as a result of, preclinical testing, clinical trials or animal efficacy studies. These issues and events could delay or prevent our ability to receive regulatory approval for a product candidate and include, among others:

§	our inability to manufacture sufficient quantities of materials for use in trials;

§	the unavailability or variability in the number and types of subjects for each study;

§	safety issues or inconclusive or incomplete testing, trial or study results;

§	lack of efficacy of product candidates during the trials;

§	government or regulatory restrictions or delays; and

§	greater than anticipated costs of trials.

For example, in February 2013, we announced results of a Phase IIb clinical trial evaluating the safety and efficacy of MVA85A in preventing tuberculosis in infants, which indicated that a single dose of MVA85A is not sufficient to confer statistically significant protection against tuberculosis in infants. As a consequence of these results, we are ceasing further development work on MVA85A.

We depend on third parties to conduct our clinical and non-clinical trials. If these third parties do not perform as contractually required or as we expect, we may not be able to obtain regulatory approval for or commercialize our product candidates and, as a result, our business may suffer.

We do not have the ability to independently conduct the clinical and non-clinical trials required to obtain regulatory approval for our product candidates. We depend on third parties, such as independent clinical investigators, contract research organizations and other third party service providers to conduct the clinical and non-clinical trials of our product candidates and expect to continue to do so. We rely heavily on these third parties for successful execution of our clinical and non-clinical trials, but do not exercise day-to-day control over their activities. Our reliance on these service providers does not relieve us of our regulatory responsibilities, including ensuring that our trials are conducted in accordance with good clinical practice regulations and the plan and protocols contained in the relevant regulatory application. In addition, these organizations may not complete these activities on our anticipated or desired timeframe. We also may experience unexpected cost increases that are beyond our control. Problems with the timeliness or quality of the work of a contract research organization may lead us to seek to terminate the relationship and use an alternative service provider, which may prove difficult, costly and result in a delay of our trials. Any delay in or inability to complete our trials could delay or prevent the development, approval and commercialization of our product candidates.

In certain cases, government entities and non-government organizations conduct studies of our product candidates, and we may seek to rely on these studies in applying for marketing approval for certain of our product candidates. These government entities and non-government organizations have no obligation or commitment to us to conduct or complete any of these studies or clinical trials and may choose to discontinue these development efforts at any time. Furthermore, government entities depend on annual Congressional appropriations to fund their development efforts.

If we are unable to obtain any necessary third party services on acceptable terms or if these service providers do not successfully carry out their contractual duties or meet expected deadlines, our efforts to obtain regulatory approvals for our product candidates may be delayed or prevented.

We may fail to select or capitalize on the most scientifically, clinically or commercially promising or profitable product candidates.

We continue to evaluate our business strategy and, as a result, may modify our strategy in the future. In this regard, we may, from time to time, focus our product development efforts on different product candidates or may delay or halt the development of various product candidates. For example, in February 2013, as a consequence of clinical trial results, we determined to cease further development work on MVA85A, our tuberculosis vaccine candidate. As a result of changes in our strategy, we may change or refocus our existing product development, commercialization and manufacturing activities. This could require changes in our facilities and our personnel. Any product development changes that we implement may not be successful. In particular, we may fail to select or capitalize on the most scientifically, clinically or commercially promising or profitable product candidates. Our decisions to allocate our research and development, management, and financial resources toward particular product candidates or therapeutic areas may not lead to the development of viable commercial products and may divert resources from better opportunities. Similarly, our decisions to delay or terminate product development programs may also be incorrect and could cause us to miss valuable opportunities.

Our strategy of generating growth through acquisitions may not be successful.

Our business strategy includes growing our business through acquisition and in-licensing transactions. We may not be successful in identifying, effectively evaluating, acquiring or in-licensing, and developing and commercializing additional products on favorable terms or at all. Competition for attractive product opportunities is intense, and may require us to devote substantial resources, both managerial and financial, to a product opportunity. A number of more established companies are also pursuing strategies to acquire or in-license products in the vaccine and therapeutic field. These companies may have a competitive advantage over us due to their size, cash resources and greater clinical development and commercialization capabilities.

Acquisition efforts can consume significant management attention and require substantial expenditures, which could detract from our other programs. In addition, we may devote resources to potential acquisitions that are never completed. Even if we are successful in acquiring a product or company, it may not result in a successfully developed or commercialized product or, even if an acquired product is commercialized, competing products or technologies could render a product noncompetitive, uneconomical or obsolete. Moreover, the cost of acquiring other companies or in-licensing products could be substantial and in order to acquire companies or new products, we may need to incur substantial debt or issue dilutive securities. If we are unsuccessful in our efforts to acquire other companies or in-license and develop additional products, or if we acquire or in-license unproductive assets, it could have a material adverse effect on the growth of our business.

Our failure to successfully integrate acquired assets into our operations could adversely affect our business.

We may not be able to integrate any acquired business successfully or operate any acquired business profitably. In addition, cost synergies, if achieved at all, may be less than we expect, or may take greater time to achieve than we anticipate.

Issues that could delay or prevent successful integration of an acquired business include, among others:

§	conforming internal controls, policies and procedures, business cultures and compensation programs;

§	consolidating corporate and administrative infrastructures;

§	consolidating sales and marketing operations;

§	retaining existing customers and attracting new customers;

§	retaining key employees;

§	identifying and eliminating redundant and underperforming operations and assets;

§	coordinating geographically dispersed organizations; and

§	managing tax costs or inefficiencies associated with integrating operations.

If we are unable to successfully integrate future acquisitions with our existing business, we may not obtain the advantages that the acquisitions were intended to create, which may materially adversely affect our business and our ability to develop and introduce new products.